Pricing Legal Claims Part II – Valuation Biases and Heuristics

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In the last post, I noted that three different sources of uncertainty affected efforts to appropriately value claims: the amount in controversy, as influenced by the revealed facts and relevant decision makers; the uncertain amount in litigation costs; and the sequential nature and nonmonotonic value of the option to settle. This post focuses on the first–the challenges of gauging the amount in controversy, including but not limited to a potential judgment value.

While even robotic litigants and attorneys would be flummoxed by the challenge of accurately assessing the amount in controversy, given the unpredictability of judicial rulings and juror deliberations, the challenge is made much more difficult by the fact that litigants and their attorneys are irrational, emotional human beings. Behavioral economics offers great insights into just how profoundly litigants’, litigators’, and even judges’ judgments are distorted by classical forms of bias.

For example, the “anchoring” bias is the tendency of people to make estimates grounded in irrelevant starting points. This bias is particularly (though not only) relevant in settlement negotiations, as research documents that people anchor to the opening offer, and thus are more likely to accept a $12,000 settlement when the initial offer was $2,000 than when the initial offer was $10,000. Or consider “hindsight bias,” which is the tendency to overestimate one’s own predictive powers and thus see past events as more predictable than they in fact were. Hindsight bias has been documented as influencing jurors’ liability determinations.

Another bias, affecting litigants and litigators alike, is “egocentric bias,” which is the tendency of people to overestimate their own abilities. This bias not only influences perceptions of claim value and thus litigation decisions at the outset of a case, but also affects how revealed information is processed. As a result, as the case progresses, opposing sides’ views of claim value can become further apart, rather than closer together. Other biases work against settlement as well: the sunk cost phenomenon,subjective psychological costs and litigation fatigue, reactive devaluation, (i.e. the desire to avoid appearing to capitulate to an adversary), and status quo bias.

One potent manifestation of the egocentric bias is the documented overconfidence of experts, including their inability to assess their predictive capabilities. Research has shown that lawyers tend to be systematically overconfident about their chances of winning. One direct impact on case value can be the lawyer’s perception of how much to spend on bringing the case, given the lawyer’s overly optimistic assessment of the claim’s value.
These biases’ distortive impacts are further reinforced by all the emotional content of a case. Plaintiffs can have nonmonetary agendas that can be even more important to them than the dollar amount at issue, such as feeling vindicated; lawyers can be driven by reputational concerns.
I find of particular note the so-called ‘availability heuristic’—reliance on the ease of retrieving an example from memory search in making judgments about the probability of events and assessing the relative importance of issues. I find this heuristic noteworthy because I am struck by how often funders and lawyers in conversation describe to me the kinds of cases they will or will not bet on based on a single negative (and sometimes positive) experience they’ve had with a case of a similar type.This is often coupled with a good faith belief that this is valuable experience that they are bringing to the table rather than a distorting bias.

Finally, and even more damaging to accurate claim valuation than bias and emotion, is the dearth of data about claim value. Few cases go to trial, and most settlement amounts are secret. If every case’s monetary value were public record, it would be possible to systematically analyze the results, identify the most potent predictive factors, and try to professionalize claim valuation. But such transparency is impossible to imagine. As a result, bias and emotion will continue to warp litigants and litigators’ perceptions of claim value. Importantly, good faith professionals, such as the lawyers and funders, can be as or even more biased than their clients in their value judgment.



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